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Wednesday, July 8, 2009 Economists are still discussing an 'exit strategy'… The economy followed the markets; now the markets follow the economy… What if the United States had to pay its debt in gold? Puru Saxena wonders what's in store for the U.S. economy: hyperinflation or deflation? --------------------- Special Offer ---------------------------   7 Big Winners Set to Soar As the World Catches...GOLD FEVER!   Gold is on the move which can only mean one thing - BIG PROFITS for gold investors! We've studied the data and found there are 3 main forces that will surely drive gold higher in the months ahead.   We'll reveal these forces as well as 5 totally underestimated precious metals companies and 2 funds that are so hot they are practically ON FIRE! Millions of investors have thrown gold to the wayside and they are going to be sorry.   The countdown is on...gold is going to lift off the launch pad...get your report NOW!   ---------------------------------------------------------------   The Long Road to Ruin by Bill Bonner London, England     The stock market seems to be rolling over. Investors read the news. It's probably becoming clear to them that the economy is not going back to normal any time soon.   Yesterday, the Dow lost another 131 points. Another big day down and it will be in the 7,000-range. Oil sank too – down to $62. The dollar, bonds, and gold stayed about where they were.   Economists are still talking about an "exit strategy." But in view of what is actually going on in the economy, they'll probably want to stay on this highway a lot longer. This is the long road to ruin, of course. It may be fatal, but it is not – yet – unpopular. Broadly, what is happening is exactly what should be happening.   The stock market rally is getting old...and may have already peaked out. The consumer is running out of time, money and credit. He has no choice but to cut back. Savings rates are rising fast – from zero to about 5% of disposable income.   Naturally, businesses are finding it hard to make sales. Earnings are collapsing...stock dividends are down sharply...   ...and of course, businesses try to cut expenses by lightening up on their payroll. When the correction began, it was led by losses in the financial sector. Those losses led to cutbacks throughout the economy. Now, it's the cutbacks that are leading to financial losses. The economy followed the markets; now the markets follow the economy. Investors are realizing that their favorite companies will find it hard to prosper in this new economic environment.   "US consumers fall behind on loans at record pace," says a Reuters headline. Delinquencies are going up on a wide range of household debt. Debtors have never had such a hard time keeping up with payments. Credit card delinquencies, for example, are running at 6.6%.   Well...duh.   And no wonder "banks get stingy on credit," as reported in the USA Today. "Despite massive government efforts to bolster the credit market, banks are pulling back severely on card lending," begins the front-page article.   Once again, we see the feds' plans failing. They give trillions to the bankers; the bankers cut back on consumer credit. And why shouldn't they? They can see what the rest of us see – the consumer can't keep up with the debt he's got already.   "Consumers aren't going to be able to save the U.S. economy this time," The Richebacher Letter's Rob Parenteau reminds us.   "Total U.S. retail sales have rolled back to levels we haven't seen since 2005. Imagine if every single retail shop opened in the last three years shut down overnight. It's already that bad.   "A lot of people, from Wall Street to Washington, have a great deal invested in you believing we can reverse that trend. But, in actuality, the freeze in consumer spending and the consumer economy could actually take many more years to thaw."   (For more from Rob on the consumer spending debacle – and to learn about the move you can make that can give you back double any further downturn in consumer sales – see here.)   At least, the consumer has wised up. He's sick of debt. He's seen where that road leads. What he wants is to get out of debt...to be free...to be safe.   It's the government that remains stuck in deep illusion... The feds know that it was too much credit that got consumers into trouble. Their solution? Give them more credit! The banks are issuing fewer credit cards than they did last year – 38% fewer. They're pushing credit limits down too – the average limit on a new card is down 3% so far this year.   Instead of passing money on to customers, the banks are using the feds' free cash to build up their own reserves...raise their salaries...and pass out bonuses. Makes sense. What else could they do with it?   More news, from The 5 Min. Forecast:   "Great news," writes Ian Mathias in today's issue of The 5. "The Federal Reserve will retain it's right to operate in secrecy.     "'Thank God for Rule 16!'"   "Late yesterday, the Senate majority put the kibosh on a last hour provision in the 2010 spending bill that would audit the Fed. Not because it's a bad idea to audit the Fed… but because of the arcane Rule 16, which prohibits policy legislation from being added to spending bills. (The kind of 'rule' that's only evoked when the majority gets uncomfortable.)   "'The Federal Reserve will create and disburse trillions of dollars in response to our current financial crisis,' said Sen. Jim DeMint, who spearheaded the failed audit addition. 'Americans across the nation, regardless of their opinion on the bailout, want to know where the money has gone.' Under his proposed plan, the Government Accountability Office would take a look into the Fed's discount window lending, various funding 'facilities,' bank bailouts and agreements with foreign players.   "Shame on Mr. DeMint for such an outrageous request. Down-to-the-wire appropriations should be reserved for truly exigent causes…like protecting the makers of wooden arrows designed for use by children. Why bother wasting the time of the GAO with a simple audit of the most unaccountable monetary body in the world?   You can watch Mr. DeMint get what's coming to him here.   Ron Paul's bill – that other shameful attempt to audit the Fed – now has 249 co-sponsors in the house. Wonder what brand of parliamentary fine print Barney Frank or Nancy Pelosi might summon to quash this one. Find more details on Ron Paul's bill – that other shameful attempt to audit the Fed – here.   Wanna make sure you get The 5 – in its entirety – sent to your inbox, every Monday through Friday? You can…by becoming a subscriber to one of Agora Financial's paid publications, such as Penny Stock Fortunes. Their latest special report details the easiest way to make money in this market – by focusing on stocks most investors overlook. Read all about it here.   And back to Bill, with more thoughts:   "Uighurs are beasts" shout crowds of Han Chinese in the remote northwest of the country. Uighurs are the Moslem minority. Han Chinese are the majority. And, judging from the photos, the Han want to kill the Uighurs.   One thing smart people always do is to underestimate the power of foolishness. It is wild and reckless to stir up a race war. But that doesn't stop people from doing it. Any kind of war is a blow to reason and civilization. But that hasn't made war unpopular, even among the most reasonable and civilized people on the planet.   It was within the lifetimes of many people reading this Daily Reckoning that the most advanced countries on earth began a war of annihilation. At the beginning of the 20th century, high culture and science were dominated by Germans. German musicians and composers...German poets and writers...German mathematicians, physicists, painters, philosophers – even the German economy was a world leader, second in output only to the United States of America.   Then, the Germans went off their heads – along with the Italians, the Russians, the Japanese...and many others.   But the Han have it right. The Uighurs are beasts from time to time. So are the Han...the Teutons...the Anglo-Saxons...and all the tribes on earth. Occasionally, for no apparent reason, the masks and restraints of civilization give way to mobs...and the old beast starts howling at the moon.   It happens in markets too. What is a bubble, if not a wild and reckless thing? A kind of madness? A mass illusion...a foolishness, in which people leave reason and civilization behind?   What if the United States had to pay its debt in gold?   In the old days, before the monetary reforms of the 20th century...notably, Richard Nixon's unilateral decision to renege on America's promise to pay its bills in gold...countries had to settle up with each other in the yellow metal. The system worked well; it was reliable; it prevented bubbles. Edward Chancellor explains:   "A country had to pay for its imports or foreign investments with money gained from a surplus on trade. If more money was sent abroad than had been earned through exports, then gold would be packed onto ships to discharge foreign creditors. A declining stock of bullion would induce the central bank to raise interest rates in order to attract gold from abroad. Rising rates would produce a credit contraction, unemployment and general economic misery. The typical nineteenth century was severe, but short- lived."   Then came the improvements. And the Great Depression. And now we are faced with another one.   Governments are fighting this one...just as they did the last one...but with much more money. The cost is in the trillions – most of it in the form of public debt. How will these debts be paid? We all expect that they will ultimately be eased by inflation – in full or in part. But suppose the feds had to pay up in real money?   Colleague Simone Wapler compared government debt to government gold. The United States has gold worth about $241 billion, she reports. Its official national debt is $11.5 trillion. That gives it a debt/gold ratio of 48 – meaning; the feds have 48 times as much debt as gold.   Britain is even worse. Prime Minister, then Chancellor, Gordon Brown sold much of England's gold at the worse possible moment – about 10 years ago. This leaves the island with only $9 billion worth of gold compared to $1,274 billion of government debt – a ratio of 1 to 139. But Japan is the worst of all. It has $23 billion worth of gold and $7.3 trillion of government debt, for a ratio of 1 to 323. (Of course, Japan has vast holdings of dollars too!)   What nation has the best gold/debt ratio? Switzerland. It has only twice as much in government debt as it has in gold.   Until tomorrow,   Bill Bonner The Daily Reckoning   P.S. If all this talk about gold has made you want to purchase some to pad your portfolio with, now is the perfect time. Byron King has found a way to get the yellow metal for just a penny per ounce…get all the details here.   --------------------- Special Offer ---------------------------   The "Forever Oil Crash" Has Already Begun   The era of "cheap oil" is long gone...but there are two investments that could give you a powerful shield against the fallout ahead - and have the potential to soar, despite the current market turmoil.   Keep reading...   ---------------------------------------------------------------   The Daily Reckoning PRESENTS: What will the future bring for the U.S. economy? Hyperinflation, or deflation? Puru Saxena contends that the United States will face neither. Find out more, in today's guest essay, below…   Hyperinflation or Deflation? by Puru Saxena Hong Kong, China   At present, the investment community is divided as to whether the world economy faces hyperinflation or deflation. Some observers are convinced that the central banks' printing press will take the world towards hyperinflation whereas others believe that the ongoing contraction in American private-sector debt will result in outright deflation. So, what will the future bring?   It is my contention that we will get neither hyperinflation nor deflation.   What is more likely is that over the coming months, we will get another deflationary scare. Any sell-off in the markets later this year will be met by an even larger stimulus from the policymakers and this will ultimately result in high inflation.   So, I maintain my view that due to the unprecedented policy responses around the globe, the world's economy will face high inflation over the medium to long-term. And the general price level will double over the coming decade.   In the near-term however, we will probably get another period when the market will (once again) become concerned about the prospects of a lengthy economic contraction. It is conceivable that the 'green shoots' hype currently doing the rounds will soon be replaced by more economic worries as a second wave of foreclosures hits America later this year. So, it is possible that before year-end, we will witness large corrections in stocks and commodities. Conversely, we are likely to see big rallies in U.S. government bonds, U.S. Dollar and Japanese Yen.   This near-term vulnerability in the markets is the reason why I have recently liquidated my 'long' positions in resources and emerging markets and gained a heavy exposure to long dated U.S. Treasuries. In my view, a defensive investment stance is prudent at this juncture, as it will protect our capital and allow profit from the expected contraction. Once the pullback in the markets is complete, I will liquidate my positions in U.S. Treasuries and re-invest our capital in our preferred holdings in energy, materials, mining and emerging Asia.   Look. In the business of investing, the tape never lies and it is worth remembering that Wall Street is littered with the graves of those who got married to one particular outcome and then held on to their ill-conceived notions. At this point, when private-sector debt contraction in America is locking horns with central bank inflation, I prefer to have an open mind. Therefore, I am maintaining a defensive near-term investment position. If the market corrects over the following weeks, I will be in a position to profit from such a decline. On the other hand, if the major indices simply consolidate here and break above the recovery highs recorded last month, then I will have no hesitation in changing my defensive investment position. Put simply, I am currently watching and waiting patiently for the market to reveal its hand. "In the business of investing, the tape never lies and it is worth remembering that Wall Street is littered with the graves of those who got married to one particular outcome and then held on to their ill-conceived notions." Coming back to the subject of this essay, the reason that I don't foresee immediate hyperinflation is because the velocity of money is currently weak. In other words, at least for the moment, the private sector in America isn't participating in Mr. Bernanke's inflation agenda. Despite the fact that Mr. Bernanke has injected a massive amount of reserves in the banking sector, this money is currently sitting as excess reserves within the American banking system. The fact that this money isn't being lent out rules out immediate hyperinflation. However, once the American economy stabilizes and the velocity of money picks up, these excess reserves will trigger a massive inflationary wave.   As far as deflation is concerned, I am of the view that the policy responses and our fiat-money system will ensure that the purchasing power of cash will continue to diminish over the medium to long-term. In fact, I am willing to bet that cash will probably be the worst performing 'asset' over the coming decade. Remember, in today's monetary system, central banks and governments the world over are free to create money out of thin air and this will prevent outright deflation in the global economy.   It is worth noting that in the past six months alone, China's commercial bank credit has expanded by a whopping US$1 trillion! Figure 1 highlights the surge in Chinese bank lending. Furthermore, credit is also expanding frantically in other Asian nations. So, contrary to the West, monetary policy is still alive and well in the developing nations and this factor also rules out outright deflation in the global economy.   Figure 1: Explosion in China's bank credit     Source: Bank of China   In my opinion, rather than hyperinflation or outright deflation, we will witness elevated inflation after the American economy has stabilized. In the interim however, investors should be prepared for another deflationary scare and the associated market panic.   Regards,   Puru Saxena for The Daily Reckoning   Editor's Note: Puru Saxena is the founder of Puru Saxena Wealth Management, his Hong Kong based firm which manages investment portfolios for individuals and corporate clients. He is a highly showcased investment manager and a regular guest on CNN, BBC World, CNBC, Bloomberg, NDTV and various radio programs.   Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.   --------------------- Special Offer ---------------------------   Only 63 People Know Why These Six Tiny Companies Will Change the World...   You're #64 - and about to become ultra-wealthy. This will go down in history as the "story of our era..." Most importantly, you'll be rich because you took decisive action in 2009.   See the full report here.   The Daily Reckoning - Special Reports: Gold: The Truth About Gold